Forms 8959 and 8960 are two relatively new forms that started with the 2014 tax year. These are two of quite a number of tax increases that are being used to help fund ObamaCare. Both of these forms affect people with income in excess of $200,000 for Single filers or 250,000 for Married Filing Jointly.

Form 8959 is the Additional Medicare Tax. It is an additional 0.9% Medicare Part A tax on combined W-2 and self-employment wages in excess of the above stated thresholds. Note that it is not based on W-2 box 1 taxable wages, but on Medicare wages which are often higher for most people. Pretax deductions such as contributions to retirement plans are included in Medicare wages, whereas they are not included in box 1 taxable wages.

Employers have to start collecting this additional tax once your wages hit the thresholds. However, if you changed jobs during the year, the second employer will not withhold until the wages your earn with that employer reaches the thresholds. This means that you could owe additional tax when you file your tax returns for the shortfall, since the new employer and old employer do not communicate to coordinate this tax. For self-employed people, you would of course be sending in quarterly estimates of your income and self-employment tax liability, and the calculation of this new tax would be made on your income tax returns at year-end.

The Form 8960 is the Net Investment Income Tax (NIIT). Once your income meets the thresholds previously discussed, you will also have an additional 3.8% tax on all investment related income. This would include income sources such as interest income, dividend income, annuities, rents, royalties, capital gains distributions from mutual funds and capital gains from the sale of investments such as stocks and bonds. Even real estate professionals would be subject to NIIT on their own rental real estate activities, unless they meet the material participation test specifically in rental real estate, which is a separate test from time spent in real estate sales activities, for instance.

If you own an interest in a business and you are not materially participating in the business, this income will also be subject to the net investment income tax. Material participation generally means 500 hours or more during the year. The sale of rental property and even second homes are also subject to NIIT. If you sell an interest in a partnership or s-corporation and do not materially participate in the business, you will also be subject to NIIT on any gains from those sales. Investment income from your children that are taxed on your returns through Form 8814 are also subject to NIIT.

Wages, unemployment compensation, alimony, Social Security benefits, tax-exempt interest income, income subject to self-employment taxes, and income from qualified retirement plan distributions are specifically excluded from the tax.

There are also some deductions that can be used to offset NIIT. These expenses included investment interest expense, investment advisory and brokerage fees, expenses related to rental and royalty income, tax preparation fees, fiduciary expenses (in the case of an estate or trust) and state and local income taxes.

Regarding trusts and estate, it is important to note that the thresholds for NIIT are much lower. Due to the compressed income tax bracket structure, NIIT kicks in when the trust or estate reaches the highest income tax bracket at only $12,300 of income (2015). This provides additional incentive for trustees to push income out to the beneficiaries since many trusts will be subject to NIIT, but the beneficiaries are often not subject due to the much higher thresholds for individuals.

Planning can be an important tool to lower the impact of NIIT.

If you have questions about other schedules or forms in your tax returns, prior articles in our Back to Basics series on personal tax returns are republished on my website at www.tlongcpa.com/blog .

Travis H. Long, CPA, Inc. is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. Travis can be reached at 831-333-1041. This article is for educational purposes. Although believed to be accurate in most situations, it does not constitute professional advice or establish a client relationship.

Today is my brother, Justin’s, birthday, and I know just what to get him. We were both avid baseball card collectors from the time we were seven and eight years old on up through our middle school years. Once, we even put on a “Kids Baseball Card Show” to buy, sell, and trade cards. We went around advertising the show with flyers on telephone polls all over the local neighborhoods, and secured the neighborhood pool clubhouse facility to host our show. It was a great success!

At the conclusion of my baseball card collecting career I had amassed over 10,000 cards with albums full of rookie cards and great players at the time. One of my most prized cards was a 1954 Topps Willie Mays. I remember wondering, how much money have I invested in all these cards over the years? Would I be able to retire after selling the cards years later? The Beckett Baseball Card Monthly price guide certainly made me think so based on the prices they listed and the rapid rates of increase. Old cards from the 1940s – 1960s were worth hundreds or even thousands of dollars each.

A few years after my interest in card collecting waned, a mass of new brands flooded the markets. That combined with other problems in baseball at the time sent the card market into an unrecoverable nose dive. Over 20 years later, most cards are still worth a tiny fraction of their peak.

Although my desire was primarily the personal fun of collecting, there were many adult investors that had serious money in cards. As with any investment bubble, I am sure there were collectors mortgaging their homes, running up credit card debt and borrowing from family in order to get a piece of the action.

As I reflect on that now, I see there would have been an opportunity for these people to take advantage of today’s topic – Form 4952 – Investment Interest Expense Deduction. If you have questions about other schedules or forms in your tax returns, prior articles in our Back to Basics series on personal tax returns are republished on my website at www.tlongcpa.com/blog .

Investment interest expense is reported on Schedule A as an itemized deduction and is essentially interest paid on debt used to buy property that produces or hopefully will produce income at some point. It doesn’t include interest expense incurred in your trade or business, or for passive activities like most rental properties. These types of interest get reported elsewhere. So, borrowing money to buy investments such as stocks, bonds, or annuities would qualify. Many financial companies offer margin loans. The interest on these loans would certainly qualify as investment interest expense if the proceeds were used to buy more stocks and bonds. Borrowing money to buy the right to royalty income or to buy property held for investment gain, such as vacant land, art, or even baseball cards would also qualify, among other things.

Due to passive activity rules which limit or even eliminate current deductions on passive rental activities such as a home you rent out, many people would like to be able to deduct the interest as investment interest instead. However, interest on passive activities is specifically excluded from being classified as investment interest expense. The interest on vacant land can usually escape this clause, even if small amounts of rent are collected since the rent is incidental to the paramount investment purpose of appreciation. To be considered incidental, the principal purpose must be to realize gain from appreciation AND the gross rents received for the year must be less than two percent of the lesser of the property’s unadjusted basis or its fair market value.

The rub with investment interest expense is that it is only deductible to the extent that you have investment income! If you have no investment income, you can’t deduct the expense, and it gets suspended until a year you actually do have investment income. So what qualifies as investment income? Well, all of the things we just discussed for which you borrowed money and can deduct as investment interest expense – so interest, dividends, gains from property held for investment, etc. Prior to being applied against investment interest expense, the investment income figure is reduced by other investment expenses that you may have reported on Schedule A – such as investment advisory fees, safe deposit boxes, investment subscriptions, etc.

By default, your net capital gains (meaning net long-term capital gains in excess of net short-term capital losses) as well as qualified dividends are not included in investment income. This is done because both of these already get taxed at favorable lower capital gains rates, so the thinking is, “Why would you want to waste a deduction to offset income that is already getting a lower capital gains rate, when you could instead use it to offset ordinary income taxed at higher rates ?” The answer is that sometimes you may not be able to ever foresee having much ordinary investment income taxable at higher rates. And instead of just suspending the deduction and getting n0 current tax benefit, you elect to include your net capital gains and qualified dividends as investment income and use the deduction to help wipe that income out, thus saving you current taxes.

The Form 4952 itself is a rather simple form – only a half page in length. Part I is a summary of the gross investment interest expense including any current interest and past interest that was carried over. Part II helps you calculate the net investment income from interest dividends, gains, capital gains, less investment expenses from Schedule A. Part III compares parts I and II and calculates the investment interest expense that will be currently deductible, as well as the part that is being suspended to the future if there is not enough investment income to absorb the expenses.

As for the card collecting Justin and I did, I sure am glad we didn’t go into debt buying baseball cards and having to file 4952s! Now about that gift – how about a box of wax packs or a factory sealed set – I know just where to get them…

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.